Starbucks Costs Retreat in Coffee Bear Market Slump: Commodities

Like many coffee growers, Nils
Solorzano Villareal figured it made sense to expand output as
prices surged to a 14-year high in 2011. Now, the 71-year-old
Costa Rican farmer is harvesting at a loss.

Record crops from Brazil to Vietnam are compounding a
global surplus that drove prices down 27 percent this year,
heading for a third annual decline and the longest slump in two
decades. Solorzano, who added trees and fertilizer to expand his
farm to four hectares (9.9 acres) from three, said he is
spending $140 to produce each 60-kilogram (132-pound) bag of
arabica-coffee beans that sells for about $132.

“We increased investments in the last few years because we
thought prices will stay high,” Solorzano said by telephone
from Montes de Oro, where he has been farming for three decades
on Costa Rica’s Pacific slopes about 130 kilometers (81 miles)
north of the capital, San Jose. “We’re still hopeful that
prices will rebound at some point. We can’t do anything else
because the land around us is very hilly.”

Global output will exceed consumption for a fourth season
in 2014, the longest glut in 11 years, the U.S government
estimates. The price of arabica traded in New York will drop 10
percent to 95 cents a pound by March, the lowest since July
2006, based on the median of 13 forecasts in a Bloomberg survey
of traders. Lower costs improved profit margins for Green
Mountain Coffee Roasters Inc., while Starbucks (SBUX) Corp. and Kraft
Foods Group cut the retail cost of packaged beans.

‘Nothing Bullish’

“There’s so much coffee around, all over, that it will
take at least one year and a half for supplies to diminish and
prices to start rebounding,” said Roberto Higgins, a director
at Guide Investimentos SA Corretora de Valores, a broker in Sao
Paulo. “There’s nothing bullish in this market.”

Prices closed today at $1.0565 a pound on ICE Futures U.S.,
heading for this year’s third-biggest loss among 24 commodities
tracked by Standard & Poor’s GSCI Spot Index, which fell 4.6
percent. Most agricultural products tumbled this year, with corn
down a record 39 percent as global crops rebounded from a 2012
drought. The MSCI All-Country World Index of equities rose 17
percent, and the Bloomberg Dollar Index climbed 3.3 percent.

Global production will expand 3.1 percent to 151.9 million
bags (9.11 million metric tons) in the year that began Oct. 1,
up 15 percent from 2008, with a surplus of 8.7 million bags,
Macquarie Bank Ltd. said in an Oct. 4 report. The glut is enough
to supply every coffee drinker for almost a year in Germany, the
largest consumer after the U.S. and Brazil. Most of the excess
are arabica varieties found in specialty coffees sold by
Starbucks and other coffee shops, the bank said.

Brazil Record

Brazil, the largest grower and exporter, will reap an all-time high of 59 million bags in the harvest that starts in
April, according to the median estimate of eight traders and
analysts surveyed by Bloomberg News. Output in the country,
which will shift next year to the high-yielding half of the
biennial cycle for trees, surged 69 percent in the past decade,
U.S. Department of Agriculture data show.

Global inventories will rise to 76.7 million bags by the
end of September 2014, boosting the ratio of stockpiles to use
to 54 percent, the highest since at least 2008, according to
Macquarie, which predicted prices will reach 90 cents by the
second quarter.

Hedge funds and other speculators have bet on lower prices
since July 2012 and had a net-short holding of 28,289 contracts
as of Nov. 5, the most since March, data from the U.S. Commodity
Futures Trading Commission show.

Stockpile Supply

Brazil, Latin America’s biggest economy, will seek to ease
the glut and limit price declines by increasing reserves. The
government sold option contracts in September and October that
allow growers to sell beans into state-owned inventories at 343
reais ($147) a bag at the end of March. If all the contracts are
exercised, stockpiles would increase by 3 million bags.

With the Brazilian harvest still five months away, the crop
remains at risk of drought damage, said Thiago Cazarini, the
president of Cazarini Trading Co. in Varginha, Minas Gerais, the
nation’s largest arabica-growing state. An outbreak of leaf
rust, a crop disease, already reduced output from Costa Rica,
Guatemala, Honduras and El Salvador.

Yields also may fall short of forecasts as lower prices
encourage growers to cut farming costs. Luz Marina Trujillo
Stewart, 60, whose family has grown coffee for more than a
century, said she will use less fertilizer at her 726-acre
plantation outside of San Jose, Costa Rica.

“We’re in a crisis zone for producers worldwide,” said
Christian Wolthers, the president of Wolthers America, an
importer in Fort Lauderdale, Florida. “Historically,
governments and private initiative tend to unite in such
situations to help stop falling prices.”

Profit Margins

Lower costs for beans will help boost operating profit
margins for Seattle-based Starbucks, the largest coffee-house
chain, by as much as 2 percentage points in the fiscal year that
began Oct. 1, after rising to 16.5 percent in fiscal 2013, Chief
Financial Officer Troy Alstead said on an earnings call Oct. 30.
The company in May cut prices for some of its packaged coffee
sold in U.S. grocery stores.

Half of the improvement in profit margins this year at
Waterbury, Vermont-based Green Mountain (GMCR), the maker of Keurig
single-serve brewers, was from cheaper beans it buys from more
than 25 countries, CFO Frances Rathke said on a call with
investors and analysts Sept. 10. The shares rose 46 percent in
New York this year.

“I don’t want to underestimate or minimize the amount that
we’re getting” from lower coffee costs, Chief Executive Officer
Brian P. Kelley said on the call. “We’re thrilled to have it,
and we’ll have it next year as well.”

Crop Expansion

Prices are dropping because farmers are now seeing the
payoff of their investments in trees, fertilizer and improved
growing techniques after coffee more than doubled from about
$1.30 a pound in mid-2010 to a peak of $3.089 in May 2011.

The number of trees planted in 2013 in Minas Gerais state,
which accounts for more than half of Brazil’s coffee output,
climbed by 78 million to 3.91 billion, from 3.832 billion a year
earlier, according to Conab, the government crop-forecasting
agency. In the past five years, yields in the country averaged
22.326 bags per hectare, 24 percent more than the five-year
average of 18.026, government data show.

Brazilian farmers will collect in 2014 the high-yielding
crop of the biennial harvest, which alternates between a high
and low cycle. Plants typically start their productive life
after three years, while pruning limbs is typically done to
boost yields.

Colombia, Vietnam

In Colombia, the second-largest arabica producer, output
will rise to the highest since 2007, according to the National
Federation of Coffee Growers. Yields will gain next year after
farmers replaced old trees with disease-resistant varieties that
are now bearing fruit, said Luis Fernando Samper, chief
communications and marketing officer at the Bogota-based group.

Vietnam, the largest grower of robusta beans, will reap 28
million bags in 2013-2014, matching the record in 2011-2012,
according to Olam International Ltd., one of the top three
suppliers of all coffee varieties. That includes about 1 million
bags of arabica.

“You have a lot of coffee from Vietnam to Brazil,” said
Rodrigo Costa, a trading director at Caturra Coffee Corp. a
dealer in Elmsford, New York. “Even if producers reduce
investments, they typically have reserves of inputs such as
fertilizers for a year. Unlike grain crops, coffee production
does not respond as quickly to a change in prices because of the
lifecycle of trees that are already planted.”